What is P/E Ratio?
PEE-to-EE ray-shee-oh
Everyday Example
If a company's share price is £100 and it earns £5 per share, its P/E ratio is 20. That means investors are paying £20 for every £1 of current earnings. If a competitor's share price is £50 with £10 earnings per share, its P/E is 5 — investors are paying far less per pound of profit.
publicReal-World Application
“The P/E ratio is one of the most widely used valuation metrics on Wall Street and the City of London. The S&P 500's long-term average P/E is around 15-16. During the dot-com bubble, tech stocks traded at P/E ratios above 100. Warren Buffett consistently emphasises buying companies with reasonable P/E ratios relative to their growth rate.”
Did you know?
Benjamin Graham, the father of value investing and Warren Buffett's mentor, popularised the P/E ratio in his 1949 classic The Intelligent Investor. He argued that paying too high a price relative to earnings — regardless of how good the company — was the most common mistake investors make.
Key Insight
A P/E ratio is meaningless in isolation — it must be compared to the industry average, the company's historical P/E, and its growth rate. A tech company with a P/E of 40 growing at 35% annually may be cheaper than a utility with a P/E of 12 growing at 2%. Context is everything.
How to Apply This
When researching a stock, check its P/E ratio against competitors in the same industry and the overall market average—if a tech company has a P/E of 15 while its peers average 25, investigate why (it might be undervalued or facing hidden problems). Never use P/E in isolation; always compare it to context.
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